ABSTRACT
This article is an empirical study of cross-market short-run correlations between order flows in the foreign exchange (FX) market and price changes in the US stock market. We argue that evidence of significant cross-market connections inform our understanding of the often observed yet still contentious relationships between FX order flow and FX returns. Specifically, some key hypotheses put forward to explain the correlation of daily order flow and spot exchange rate changes are not consistent with cross-market correlations. The one explanation that is consistent is that order flows contain information and that this is impounded into FX rates through the trading process. We also argue that our results shed some light on the nature of the information in order flow. At its most basic, the results suggest that at least part of the information content in flows relates to fundamentals relevant to both stock and FX markets. While this may not appear to narrow the field much, it does suggest that non-fundamental information in order flow – often thought of in terms of the ability of flows to predict future flows – is not the whole story. Further, we find considerable differences between the impact of order flow from corporate customers and that from financial customers, both in terms of the signs of the correlations and the horizons over which these correlations are significant. This suggests that the information in the flows from these different groups of end-users is radically different.
